The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Monday, April 25, 2011

Updated: What Wednesday's inflation numbers mean for you...

Oh, some boring inflation numbers, eh? Truth be known, Australia's inflation rate, which will be published by the ABS on Wednesday at 11.30am, holds tremendous meaning for us all. (For a more detailed primer on inflation, have a read of this guide.)

It will determine what the RBA does with interest rates, and, as a consequence, the amount you repay on your mortgage, your earnings on your bank deposits, and, in all likelihood, changes to the level of the exchange rate (the Aussie dollar), and hence the price of our exports, and our purchasing power overseas.

I am in Los Angeles right now, and it's great having the AUD/USD pair at around 1.07. Yet the surge in the Aussie makes for some curious cost comparisons. Food is much cheaper in LA relative to what we pay in Sydney. As is the price of a luxury car. A standard Porsche 911 will set you back about A$75,000. Back home you are paying well north of $200k.

So, when looking at the inflation data, there are only two numbers you really have to focus on: the "headline" inflation rate, and the "core" inflation rate. Now economists and markets tend to incorrectly ignore the headline and focus on just the core, because that is what the RBA has encouraged them to do.

The core inflation measure removes all the very high growth and low growth expenditure classes--eg, in this quarter, the price of various food items and petrol. But we consumers do not get the benefit of this core inflation. We get stuck with the headline numbers. We get hit with the cost of food and petrol. So if you want a feel for what is actually happening to your cost of living, watch the headline results. You can bet that it will paint a much uglier picture than the core benchmarks.

The RBA has pre-warned everybody that they intend to ignore the headline figures this quarter because of the price shocks imposed on us via sundry natural disasters and the Middle Eastern imbroglio. So, in terms of working out what is going to happen to deposit rates, mortgage rates, and the currency, we need to concentrate particularly on the core findings even though they don't actually mean much to the man or woman on the street. In this respect, I think there is a pretty straightforward guide as to what the core estimates will tell us:

1/ If core inflation in the quarter comes out at 0.8% or higher, this implies an annualised rate of underlying inflation greater than the top of the RBA's target 2-3% per annum band, which it has struggled to hit over the last decade. This will be a major surprise to economists and financial markets, and the Aussie dollar will rally hard. The consensus economist view is that core will print at between 0.6% to 0.7% for the quarter, or in the middle of the RBA's target band. Very few economists expect an expansion in these underlying price pressures. Indeed, none are projecting a core rate of inflation greater than 0.8%. So if we do see a 0.8% or higher number, it will mean that barring any more disasters, interest rates are heading up very soon, most probably in June or July, but possibly May depending on how high the core number is (eg, a 0.9% to 1.0% outcome would tip everybody into a frenzy and could trigger a rate response at the next meeting notwithstanding the Budget). But, to be clear, nobody is currently expecting this to happen!

2/If core inflation comes out at 0.6% to 0.7%, this will be smack-bang in line with forecasts, and is likely to mean that the RBA has more time to work out what it wants to do. Rates will be on hold and the Aussie dollar should not move much. The focus for future RBA decisions will then shift to the monthly unemployment numbers and the wages data. Whether these results are strong or weak will determine whether the RBA goes in the third or fourth quarters.

3/Finally, if core prints at 0.5% or less, this will be a very "dovish" (low inflation) outcome, which will mean that economists and the market will start talking about no further interest rate hikes this year at all, subject, of course, to other variables, like wages and unemployment. If this comes to pass, the Aussie dollar should fall a fair bit. This scenario is very good news for anyone with a mortgage. Unfortunately, however, this low inflation result will likely have been driven by deflation in discretionary consumer items, and not staples like food and petrol. That is, poorer households will still be feeling the pinch given what should still be a very high "headline" inflation print of close to, or greater than, 1%.

I hope this helps clarify your thinking on what can be a murky topic.